The 2011 Estate Tax Changes

I guess I was slightly off on my prediction on what the 2011 estate tax environment would look like. On December 17, 2010, President Obama signed the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, or TRUIRJCA, but I will call it the "tax compromise." One thing I will discuss is that this estate tax regime only exists for 2011 and 2012 and the "old" 2011 rules that had many people indecisive in 2009 and 2010 returns in 2013.

Exemption Level and Rate

Since 2001, the federal estate tax exemption level has risen while the tax rate has dropped to the point where there was no federal estate tax in 2010. Without the tax compromise, the federal estate tax would have returned in 2011 with a federal estate tax exemption of approximately $1.0 million with a top end tax rate of fifty-five percent (55%). The tax compromise followed most of the "Lincoln/Kyl proposal" I described in my September Newsletter. The federal estate tax exemption level will be $5.0 million per person with a tax rate of thirty-five percent (35%) on estate assets above that level. The exemption level will rise with inflation. Many states have their own state estate tax that were not impacted by the tax compromise.

Gift Tax Re-Unified with Estate Tax

When Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") was passed in 2001, the gift tax exemption levels were split from the estate tax exemption levels. While the estate tax exemption level eventually rose to $3.5 million and 45% rate, the lifetime gift tax exclusion remained at $1.0 million with a tax rate equal to the givers income tax rate and topping out at rate of thirty-five percent (35%). In other words, depending on a person's financial situation people, under EGTRRA, it made economic sense for some to give gifts in excess of $1.0 million but for others it didn't. The tax compromise changes that calculation and re-unifies the gift tax, generation skipping transfer ("GST") tax 1 and estate tax. For 2011 and 2012, the gift tax exemption level is the same as the federal estate tax level of $5.0 million and with a tax rate of thirty-five percent (35%) for gifts above that amount.


While there has been talk about it in the past, one of the items in the tax compromise that shocked many estate planners was the applicability of portability between spouses of assets with respect to the federal estate tax exemption. For example, if Husband A dies using up only $2.5 million of their federal estate tax exemption, then the Wife has a $7.5 million exemption on the remaining assets - the wife's $5.0 million exemption plus the remaining $2.5 million exemption from Husband A. This means a married couple can have $10 million in assets exempted from the federal estate tax.

There are a couple of caveats. First, an estate tax return must be filed with an election with the IRS to "preserve" the portability. Second, if the surviving spouse gets remarried and the second spouse dies prior to the surviving spouse then the surviving spouse will get the federal exemption level of the second dying spouse. From the above example, if Wife remarries to Husband B and Husband B dies before Wife and uses up $4.0 million of his federal estate tax exemption then Wife only has $6.0 million as portable because the exemption is keyed off of the amount of the federal exemption used by the last spouse.

In reality, portability has codified what many people already do in their estate planning by creating what are known as A/B trusts or "credit" shelter trusts though portability is not as flexible as a trust.

What about 2010?

The tax compromise also impacted the non-existent estate tax of 2010. As I described in my May Newsletter, people inheriting property from a decedent dying in 2010 lost their step up in basis in the inherited assets for capital gains tax purposes. The tax compromise offers a choice for those dying in 2010:

  1. No estate tax, with modified carryover basis for inherited assets (the EGTRRA 2010 rule), or
  2. The estate tax in effect for 2011, with step-up in basis for inherited assets.
This allows a personal representative the option of selecting the estate tax system that provides a lower tax bill. For example, the Steinbrenner's are going to choice option 1 because the carryover basis doesn't occur until a sale. But, someone with $4 million estate comprised of assets with large capital gains, like a home owned for a long time, will choose option 2.

Only for Two Years

That's right. All the politicians just kicked the estate tax can down the road for two more years. The entire estate tax regime only lasts for 2011 and 2012, and the entire tax world will be right back to the same level of uncertainty in the fall of 2012. With a Presidential election in 2012, I can't foresee anything hindering the ability to resolve this, do you? I hope your sarcasm meter was on for the last sentence.

Regardless of the future, at least some direction is provided for people to plan their estate.

Basics of Estate Plannign: Qualified Terminable Interest Property Trusts

With the current federal estate tax exemption to jump to $5 million a person and $10 million a couple, many people will ask whether there is a need to create trusts. However, there are going to be situations where some type of trust is necessary. For example, in the Estate of the Month describing my grandfather's estate, a second marriage mixing two families demonstrates the need for additional estate planning. One type of trust, a qualified terminable interest property trust, or "QTIP trust," would aid in trying to placate inter-generational and mixed family strife.

A QTIP trust is created enabling the grantor to provide for a surviving spouse and also to maintain control of how the trust's assets are distributed once the surviving spouse has also died. Income, and sometimes principal, generated from the trust is given to the surviving spouse to ensure that he or she is taken care of for the rest of his or her life. However, the surviving spouse's has no ownership or control of the trust assets. When the surviving spouse dies, ownership of the trust's assets passes to the beneficiaries named in the QTIP trust.

A QTIP trust allows for grantor-spouse to ensure that the surviving spouse is taken care of through use of the trust income but also safeguard the inheritance of any beneficiary, usually the grantor-spouse's child. In an example, the grantor-spouse of the QTIP trust is in a second marriage and has three children from a previous marriage causing a natural tension between the two. By creating a QTIP trust, the grantor hopes to meet the surviving spouse's needs of income to live off of and still provide an inheritance to the three children.

The benefits of a QTIP trust are multi-faceted. First, it provides control of your estate after your passing by restricting the ability of the surviving spouse to claw into the trust principle, if a settlor wishes. A QTIP trust can oversee and manage the distribution of the trust upon the passing of the surviving spouse and can also manage assets for a spouse who manages their finances poorly. QTIP trusts also protect assets from the surviving spouse's creditors. Since the spouse does not own the assets in the trust, creditors cannot attach liens to the trust property.

It is also a tax-saving mechanism. A QTIP trust is protected by the marital deduction and assets are not taxed until passing of the surviving spouse. Further, taxes owed upon the surviving spouse's death can generally be taken from the QTIP assets and not from the other surviving spouse's assets. It is also a tax-saving mechanism. A QTIP trust is protected by the marital deduction and assets are not taxed until passing of the surviving spouse. Further, taxes owed upon the surviving spouse's death can generally be taken from the QTIP assets and not from the other surviving spouse's assets.

Like everything in life, there are some drawbacks. QTIP trusts have strict guidelines and several concerns that someone should be aware of when drafting a QTIP trust. All of the income generated from the trust must go to the surviving spouse for his/her lifetime and not to anyone else. The surviving spouse cannot use trust assets to benefit a new spouse or their own children.

Another issue that must be touched upon is the level of trust between the surviving spouse and inheriting children. Typically, the surviving spouse will want the QTIP trust to produce as much income as possible while the subsequent beneficiaries will want to preserve principle in the trust. Those two issues require different investing strategies. There are also the spendthrift issues that could appear in the view of the inheriting children. For example, does the surviving spouse really need that new automobile or vacation to European? Only open lines of communication between all the parties can alleviate those concerns.

Estate of the Month: Elizabeth Edwards - And Why the Press is Probably Wrong

Elizabeth Edwards, the estranged wife of 2004 vice presidential candidate and former North Carolina senator John Edwards, died on December 7th, 2010, after a lengthy battle with cancer.

The interesting part is the news that came out only a few days ago. Most newspapers stated that Elizabeth Edwards disinherited John Edwards leaving all of her assets to her children. Here are a few headlines:

However, the press has no idea if she did or did not cut off her estranged husband based on the published will. I will ignore the implications that John Edwards could take an elective share of her estate2 and focus in on her last will and testament and what the specifics are.

She executed a new will on December 1, 2010, just a few days before her death. In Article IV, she left all of her tangible property, aka cars, furniture, jewelry, etc. to her children which most newspapers assumed meant all of her assets. That is not the case. In Article V, she stated that all the residual of her estate, meaning all the rest of her probate assets which could be a home, stocks, or cash, to "pour-over" into to her revocable trust she had created on December 2, 1992.

Because a trust is a private document, it prevents the press from seeing specifically who does inherit her assets. Maybe she still left something to John Edwards after the separation, but, maybe she did not. The beauty of a trust for a famous person, like Elizabeth Edwards, who became famous due to the political aspirations of John Edwards and their infamous separation, is that the press will never find out any specifics because the trust is not a public document unlike a will.

As for her trust, it was created when the Edwards were considered happily married. More than likely, at that time, she left all of her assets to her husband. But, in her will she states that her revocable living trust has been amended and restated prior to the execution of the December 1st will and appointed her daughter, Catherine Edwards, as trustee. It is more than likely that appointing Catherine as Trustee was a change from a prior will since most parents appoint their surviving spouse as trustee then appoint their children as successor trustee(s) if the surviving spouse cannot serve.

So, how does this apply to the everyday person? If a person feels there could be family strife over inheritance having a document that does not have to be displayed publically, like a trust, would go a long way toward limiting challenges or preventing ill-will toward a beneficiary that appears to receive more. A will must be publically filed with the state to go through probate, meaning anyone can see it, whether they inherit a share of a person's estate or not. A trust is "secret" and only a few people can see it. The ability to challenge an estate's disbursement under a trust are more limited because a person does not know whether someone else is getting more or not.

As Elizabeth Edwards will and estate plan demonstrates, even the press can jump to conclusions about who did or did not inherit with what is a rather simple four page will. She took the steps to ensure the privacy of her estate; if a person feels privacy could be an issue in their family, having a similar pour-over will and revocable living trust could be a good idea.


1 The GST tax imposes a tax on both outright gifts and transfers in trust to or for the benefit of unrelated persons who are more than thirty-seven and half (37.5) years younger than the donor or to related persons more than one generation younger than the donor, such as a gift from a grandparent to a grandchild. The generation-skipping tax will be imposed only if the transfer avoids incurring a gift or estate tax at each generation level..

2 An elective share is a term, which describes a proportion of an estate which the surviving spouse of the deceased may claim in place of what they were left or not left in the decedent's will. It may also be called a widow's share, statutory share, election against the will, or forced share. It was conceived to prevent a surviving spouse from falling into poverty and becoming a burden on the community.


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